INVENTORY

(PAS 2)
Definition
PAS 2 defines inventories as assets:
● Produced and held for sale in the ordinary course of business
(finished goods inventory)
● In the process of production for such sale (work in process
inventory)
● In the form of materials or supplies to be consumed in production
(raw materials inventory)
● Purchased and held for resale in the ordinary course of business
(merchandise inventory)

2
Recognition
Inventories are recognized when they meet the definition of inventory
and they qualify for recognition as assets, such as when legal title is
obtained by the buyer from the seller.

Ownership over inventories

An entity shall report in its financial statements all inventories over
which it holds legal title to or has obtained control of the related
economic benefits.

3
 1
Goods in Transit,
Freights
Goods in Transit
pertain to goods already shipped by the
seller but are not yet received by the buyer.

5
FOB Shipping Point
Ownership over the goods is transferred upon shipment.
The buyer records debit Purchases and credit Accounts
Payable upon shipment.
Ownership: Buyer

Other terms: FOB Seller; Cost, Insurance, & Freight (CIF); Free
alongside ship (FAS)

6
FOB Destination
Ownership over the goods is transferred only when the
buyer receives the goods.
The buyer records debit Purchases and credit Accounts
Payable when the goods are received.
Ownership: Seller

Other terms: FOB Buyer; Ex-ship

7
Freight Prepaid
the seller pays for the freight in advance before
shipment

Freight Collect
freight is not yet paid upon shipment. The carrier
collects shipping cost from the buyer upon
delivery
8
Illustration:
ABC Co. purchased goods with invoice price of P1,000 on account on
December 27, 20x1. The related shipping costs amounted to P10. The
seller shipped the goods on December 31, 20x1. The goods were
received on January 2, 20x2 and the account was settled on January 5,
20x2.
Dates to remember:
December 27, 20x1- The company purchased goods
December 31, 20x1- The goods were shipped
January 2, 20x2- The goods were received
January 5, 20x2- The account was settled

9
Illustration:
FOB Shipping point, freight collect
Dec. 31, Purchases 1,000
20x1
Accounts Payable 1,000
Jan. 2, Freight-in 10
20x2 Cash 10
Jan. 5, Accounts Payable 1,000
20x2 Cash 1,000

Purchases Cash Freight-in

1,000 1,010 10

10
Illustration:
FOB Destination, freight prepaid
Dec. 31,
20x1 NO ENTRY
Jan. 2, Purchases 1,000
20x2 Accounts Payable 1,000
Jan. 5, Accounts Payable 1,000
20x2 Cash 1,000

Purchases Cash Freight-in

1,000 1,000

11
Illustration:
FOB Shipping point, freight prepaid
Dec. 31, Purchases 1,000
20x1
Freight-in 10
Accounts Payable 1,010
Jan. 2,
20x2
NO ENTRY

Jan. 5, Accounts Payable 1,010

20x2 Cash 1,010
Purchases Cash Freight-in

1,000 1,010 10

12
Illustration:
FOB Destination, freight collect
Dec. 31,
20x1 NO ENTRY
Jan. 2, Purchases 1,000
20x2 Accounts Payable 990
Cash 10
Jan. 5, Accounts Payable 990
20x2 Cash 990

Purchases Cash Freight-in

1,000 990
10
1,000

13
 2

Ownership
Consigned Goods
Pertain to goods transferred by a consignor to a consignee who
will act as an agent of the consignor in trying to sell the goods.
Ownership: Consignor
Only a memo entry is normally used in recording the
consignment. Incidental costs of transferring consigned goods to
the consignee form part of the cost of the consigned goods.
Maintenance costs are charged as expenses.

15
 Inventory Financing Agreements
Product Financing Agreement/ Goods
Sold with buyback Agreement
A seller sells inventory to a buyer but assumes an obligation to repurchase it at a later date.
This arrangement does not result to the transfer of control over the asset.
Ownership: Seller

Pledge of Inventory
A borrower uses its inventory as collateral security for a loan. This arrangement does not
result to the transfer of control over the asset.

Ownership: Debtor

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Inventory Financing Agreements
Warehouse Financing
A third party holds the inventory and acts as the creditor’s agent. This arrangement does not
result to the transfer of control over the asset
Ownership: Debtor

Loan of Inventory
An entity borrows inventory from another entity to be replaced with the same kind of
inventory. This arrangement results to transfer of control over the asset.

Ownership: Borrower

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Sale with Right of Return
The buyer normally recognizes goods purchased under a sale with right of return at the
time of sale.
Ownership: Buyer

Sale on trial (or approval)

A seller allows a prospective customer to use a good for a given period of time with an
option to purchase the same after the specified period. The legal title over the good does
not pass to the prospective customer until he approves it and purchases it.
Ownership: Seller
In some arrangements, the good is considered sold if it is not returned within a reasonable
period of time after the trial period has lapsed

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Installment sale
An installment sale where the possession of the goods is transferred to the buyer but the seller
retains legal title solely to protect the collectability of the amount due is considered as a regular
sale.
Ownership: Buyer

Bill and hold sale

A contract under which an entity bills a customer for a product but the entity retains physical
possession of the product until it is transferred to the customer at a future date.
Ownership: Buyer

Lay away sale

A type of sale in which goods are delivered only when the buyer makes the final payment in a
series of installments.
Ownership: Seller
However, when significant payments have already been made, the goods may be included in
the buyer’s inventory provided delivery is probable.
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Illustration:
The records of ABC Co. show the following:
Goods sold on an installment basis to XYZ Inc., title to the
goods is retained by ABC Co. until full payment is made.
XYZ Inc. took possession of the goods P750,000
Goods sold to Alpha Co. for which ABC Co. has signed an
agreement to repurchase the goods sold at a set price that
covers all costs related to the inventory 680,000
Goods sold where large returns are predictable 270,000
Goods received from Beta Co. for which an agreement as
signed requiring ABC Co. to replace such goods in the near 580,000
future

How much is included as part of ABC Co’s inventory?

20
Illustration:
Goods sold on an installment basis to XYZ Inc., title to the
goods is retained by ABC Co. until full payment is made.
XYZ Inc. took possession of the goods P750,000
Goods sold to Alpha Co. for which ABC Co. has signed an
agreement to repurchase the goods sold at a set price that
covers all costs related to the inventory 680,000
Goods sold where large returns are predictable 270,000
Goods received from Beta Co. for which an agreement as
signed requiring ABC Co. to replace such goods in the near 580,000
future

P1,260,000

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 3
Accounting for
Inventories
Perpetual Inventory
System
● The “Inventory” account is updated for each purchase and
sale of inventory.
● No physical count is needed in determining COGS and
ending inventory.
● “Cost of goods sold” is debited and “Inventory” is credited each
time a sale is made.

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Periodic Inventory System
● The “Inventory” account is updated only when a physical count is
performed.
● No entry is made to recognize cost of goods sold when inventory is
sold.

Beginning inventory xx
Purchases xx
Add: Net purchases* xx
Add: Freight-in xx
Total goods available for sale xx
Less: Purchase returns, allowances and
Less: Ending inventory (physical count) (xx) discounts (xx)
Cost of goods sold xx Net purchases* xx

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Periodic Inventory System

Inventory Inventory
Beg. Inventory COGS Beg. Inventory Purchase discounts
Net purchases Purchases Purchase returns
Sales Return Freight-in COGS
Sales return
Ending inventory
Ending inventory

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Illustration:
Perpetual System Periodic System
1. The entity purchased goods worth P1,000 on account
Inventory P10,000 Purchases P10,000
Accounts Payable P10,000 Accounts Payable P10,000
2. The entity paid shipping costs of P1,000 on the purchase above
Inventory 1,000 Freight-in 1,000
Cash 1,000 Cash 1,000
3. The entity returned the damaged goods worth P2,000 to its supplier
Accounts Payable 2,000 Accounts Payable 2,000
Inventory 2,000 Purchase returns 2,000
4. The entity sold goods costing P5,000 for P20,000 on account

Accounts Receivable 20,000 Accounts Receivable 20,000

Sales 20,000 Sales 20,000
Cost of goods sold 5,000
NO ENTRY
Inventory 5,000

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Illustration:
Perpetual System Periodic System
5. The entity purchased goods worth P1,000 on account
Sales Returns 800 Sales Returns 800
Accounts Receivable 800 Accounts Receivable 800
Inventory 200
NO ENTRY
Cost of goods sold 200

Using Perpetual System:

Inventory
COGS
10,000 2,000
5,000 200 1,000 5,000
200
4,800
4,200

27
Illustration:
Solving for COGS using the Periodic Inventory System:
During the physical count, it was revealed that the inventory left amounted to 4,200

Purchases 10,000

Freight-in 1,000

Purchase returns (2,000)

Net Purchases 9,000

TGAS 9,000

Ending inventory (4,200)

COGS 4,800

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Measurement
Inventories are measured at the lower of cost and net realizable
value (NRV).

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 4

Cost
Cost
● The cost of inventories comprise all:
● Costs of purchase – include:
○ Purchase price
○ Import duties
○ Transport and handling costs (freight-in)
○ Other costs directly attributable to the acquisition of finished goods, materials and
services
● Discounts- Trade discounts, rebates and similar items are deducted in determining the
costs of purchase.
● Costs of conversion- include costs incurred directly in converting raw materials into
finished goods. Conversion costs include direct labor and variable and fixed production
overheads.
● Other costs – include only those incurred in bringing the inventories to their present
location and condition.

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Cost
● The following costs should be excluded from cost of inventories and
recognized as expenses in the period in which they are incurred:
○ Selling costs (i.e. advertising, promotion costs, delivery expense or freight
out)
○ Abnormal amounts of wasted materials, labor or other production costs
○ Storage costs, unless those costs are necessary in the production
process
○ Administrative overheads
The cost of purchase does not include taxes paid which are subsequently recoverable
(i.e. VAT paid by VAT payers)
● Interest expense incurred on borrowings (borrowing costs) made to finance the
acquisition or production of an inventory that meets the definition of a
qualifying asset forms part of the cost of the inventory. All other interests are
charged as expenses.

32
Cost formulas
First-in, First-out (FIFO) cost formula
● This cost formula assumes that the items of inventory that
were purchased or produced first are sold first.
● Cost of goods sold represents costs from earlier purchases
while cost of ending inventory represents costs from the most
recent purchases.
● A unique characteristic of FIFO formula is that it yields the
same amounts of cost of goods sold and ending inventory
when applied in either a perpetual or periodic system.

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Illustration:
Date Transaction Units Unit cost Total cost
1-Aug. Inventory 2,000 P36.00 P72,000
7 Purchase 3,000 37.20 111,600
12 Sales 4,200
13 Sales return 600
21 Purchase 4,800 38.00 182,400
22 Sales 3,800
29 Purchase 1,900 38.60 73,340
30 Purchase Return 300 38.60 (11,580)
Total goods available for sale P427,760

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Illustration:
FIFO periodic
Beg. Inventory in units 2,000 TGAS in pesos 427,760

Net purchases in units 9,400 Ending inventory at cost (152,960)

TGAS in units 11,400 Cost of goods sold P274,800

Quantity of goods sold (7,400)

Ending inventory in units 4,000

Units Unit cost Total cost

Ending inventory in units 4,000
Net purchases form Aug. 29 (1,600) 38.60 P61,760
2,400
Purchases from Aug. 21 (2,400) 38.00 91,200
Ending inventory at cost - P152,960

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FIFO perpetual
Date Transaction Units Unit cost Total cost
1-Aug. Inventory 2,000 P36.00 72,000
7 Purchase 3,000 37.20 111,600
12 Net Sales (3,600)
Allocation:
From beg. Inventory 2,000 36.00 (72,000)
From Aug. 7 purchase 1,600 37.20 (59,520)
21 Purchase 4,800 38.00 182,400
22 Sales (3,800)
Allocation:
From Aug. 7 purchase 1,400 37.20 (52,080)
From Aug. 21 purchase 2,400 38.00 (91,200)
29 Net Purchase 1,600 38.60 61,760
Ending inventory at cost P152,960

COGS= (72,000+59,520+52,080+91,200) = 274,800

36
Cost formulas
Weighted average cost formula
The cost of each item is determined from the weighted
average of the cost of similar items purchased or
produced during the period. The average may be
calculated under either periodic or perpetual system.

37
Cost formulas

38
Illustration:
WAC= TGAS in pesos
TGAS in units Ending Inventory in units 4,000

= 427,760 Multiplied by: WAC 37.52

11,400* Ending Inventory at cost 150,080

= P37.52
TGAS at cost 427,760
Beg. Inventory in units 2,000 Ending Inventory at cost (150,080)
Net purchases in units 9,400 Cost of goods sold 277,680
TGAS in units *11,400

Quantity of goods sold (7,400)

Ending inventory in units 4,000

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Cost formulas
Moving average- Perpetual
A new or moving weighted average cost is determined after every
purchase or as each shipment is received by dividing total goods
available for sale as of that date by the total quantity of goods available
for sale as of that date.
The moving average unit cost is then multiplied by the quantity of goods
sold after the latest purchase to determine cost of goods sold or by the
quantity of inventory on hand to determine ending inventory.

40
Illustration:
Date Transaction Units Unit cost Total cost
1-Aug. Inventory 2,000 P36.00 72,000
7 Purchase 3,000 37.20 111,600
Moving ave. unit cost (183,600/5,000) 5,000 36.72 183,600
12 Sales (4,200) 36.72 (154,224)
13 Sales return 600 36.72 22,032
21 Purchase 4,800 38.00 182,400
Moving ave. unit cost (233,808/6,200) 6,200 37,71 233,808
22 Sales (3,800) 37,71 (143,298)
29 Purchase 1,900 38.60 73,340
30 Purchase Return (300) 38.60 (11,580)
Ending inventory 4,000 P152,270

COGS= (154,224-22,032+143,298)= P275,490

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 5

Discounts
Trade Discounts
● Given to encourage orders in large quantities.
● Do not form part of the cost of inventory; they are
directly deducted from the list price.
● They are not recorded in the books of buyer nor
seller.

43
Cash Discounts
● Given to encourage prompt payment.
● They are deducted from invoice price in order to determine the
amount of net payment required within the discount period.
● Accounted through either net method or gross method.

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Accounting for Cash Discounts
Gross Method
● The cost of inventory and accounts payable are recorded gross of cash discounts.
● Purchase discounts are recorded under the “Purchase discounts” account only
when taken.
● Purchase discount is deducted from gross purchases when computing for net
purchases.

Net Method
● The cost of inventory and accounts payable are recorded net of cash discounts,
regardless of whether such discounts are taken or not.
● Purchase discounts not taken are recorded under the “Purchase discounts lost”
account and included as part of “other expenses” or as “finance cost” (interest
expense).

45
Illustration:
An entity purchases inventory with a list price of 10,000 on account under credit terms of 20%, 10%, 2/10, n/30.

Gross Method Net Method

1. Purchase of inventory
Purchases 7,200 Purchases 7,056
Accounts Payable 7,200 Accounts Payable 7,056
(10,000x80%x90%) (10,000x80%x90%X98%)
Trade discounts are deducted from the list price to Trade discounts and cash discounts are deducted from the
determine the invoice price gross of cash discounts list price to determine the invoice price net of cash
discounts
2. Assume payment is made within discount period
Accounts payable 7,200 Accounts payable 7,056
Purchase discount 144 Cash 7,056
Cash 7,056
3. Assume payment is made beyond discount period
Accounts payable 7,200 Accounts payable 7,056
Cash 7,200 Purchase discount lost 144
Cash 7,200

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 6
Net Realizable
Value (NRV)
Net realizable value
(NRV)
Estimated selling price in the ordinary course of business
less the estimated costs of completion and the estimated
costs to sell.

48
Write-down to NRV
● In cases where NRV<Cost; the inventories may need to be written down
to their net realizable value.
● The excess of cost over NRV represents the amount of write-down. If
the cost of an inventory is lower than its NRV (NRV>Cost), no write-down
is necessary.
● Write-downs of inventories to NRV are normally charged to cost of
goods sold in the period of write-down. However, write-downs due to
abnormal losses are charged to loss.

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Illustration:
ABC Co. buys and sells product A & B. The following unit costs are available for the inventory as
December 31, 20x1: (All costs are borne by ABC Co.)

Product A Product B
Number of units 2,000 3,000
Purchase cost per unit P100 P200
Delivery cost from supplier 20 30
Estimated selling price 150 250
Selling costs 22 40
General administrative 15 18

Requirements:
a. Determine the amount of write-down. Provide the adjusting entry.
b. Compute for the valuation of the inventories in ABC’s December 31, 20x1 statement of
financial position.

50
Illustration:
a.
Product A Product B
Cost:
Purchase cost per unit P100 P200
Delivery cost from supplier 20 30
Cost per unit 120 230
Net Realizable Value:
Estimated selling price 150 250
Selling costs (22) (40)
NRV per unit 128 210
Lower of cost and NRV 120 210
(cost) (NRV)

Dec. 31, 20x1 Cost of goods sold (230-210x3,000 units) 60,000

Inventory 60,000

51
Illustration:
b.
Product A Product B
Lower of cost and NRV 120 210
Multiplied by: Number of 2,000 3,000
units
Inventory, Dec. 31, 20x1 240,000 630,000

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Reversal of Write-downs
● When there is clear evidence of an increase in NRV
which was previously written down below cost, the
amount of write-down is reverted in profit or loss in the
period of such reversal so that the new carrying amount
is the lower of the cost and the revised NRV.
● However, the amount of reversal to be recognized
should not exceed the amount of the original write-
down previously recognized.

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Illustration:
ABC Co. has the following comparative information regarding its inventories.

20x1 20x2
Cost 240,000 330,000
NRV 220,000 300,000

Requirement: Provide journal entries in 20x1 and 20x2

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Illustration:
20x1 20x2
Cost 240,000 330,000
NRV 220,000 300,000
COGS before adjustments 2,000,000 1,800,000

Dec. 31, Cost of goods sold (240k-220k) 20,000

20x1 Inventory 20,000
Dec. 31, Inventory 20,000
20x2 Cost of goods sold 20,000

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Gets?
If you have questions, now is the best
time to raise them ☺

56
PRACTICE
PROBLEMS
Problem 1
The inventory records of BINI Co. on December 31, 20x1 shows a balance of 260,000. The following
information was also gathered:
a. Goods costing 10,000, purchased under FOB shipping point, were not included in the ledger
balance because these were still in transit as of December 31, 20x1. The supplier shipped the goods
on December 30, 20x1 and prepaid the freight of 1,000.
b. Goods costing 5,000 were received on December 31, 20x1. These were recorded on January 3,
20x2.
c. Goods costing 16,000 were shipped to a customer on December 31, 20x1 on an FOB shipping
point term. The goods were included in the ledger balance because the customer received the
shipment only on January 4, 20x2.
d. Goods costing 20,000 were shipped to a customer on December 31, 20x1 on an FOB Destination
term. The goods were not included in the balance because the goods were already dispatched
when the inventories were counted at 11pm on December 31, 20x1.
How much is the correct inventory of BINI Co. on December 31, 20x1?

a. 311,000 c. 280,000
b. 279,000 d. 312,000

58
Problem 1- Solution

Unadjusted Inventory 260,000

Purchased goods in transit under FOB Shipping 11,000
point and freight-in
(10k+1k)
Unrecorded goods 5,000
Goods in transit sold through FOB shipping point (16,000)
Goods in transit sold through FOB destination 20,000
280,000

c. 280,000

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Problem 2
Information on Hercules Mulligan’s Hot Pants Co.’s inventories is shown below:

20x1 20x2

Cost 600,000 900,000

NRV 400,000 650,000

How much is the reversal of write-down to be recognized?

a. 200,000
b. 250,000
c. 300,000
d. 350,000

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Problem 2- Solution
20x1

Cost 600,000

NRV 400,000

20x1 Cost of goods sold (600k-400k) 200,000

Inventory 200,000

20x1 20x2

Cost 600,000 900,000

NRV 400,000 650,000

20x2 Inventory 200,000

Cost of goods sold 200,000

a. 200,000
61
Problem 3

Beg. Inventory 20,000

Purchases 41,000
Purchase returns and allowances 3,000
Purchase discounts 4,000
Goods available for sale 55,000
Cost of goods sold 22,000

How much is the Freight-in?

a. 3,000
b. 4,000
c. 2,000
d. 1,000

62
Problem 3- Solution

Goods available for sale 55,000

Less: Beg. Inventory (20,000)
Net purchases 35,000
Add: Purchase returns and allowances 3,000
Purchase discounts 4,000
Less: Gross purchases 41,000
Freight-in 1,000

d. 1,000

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Problem 4

Beg. Inventory 20,000

Purchases 41,000
Purchase returns and allowances 3,000
Purchase discounts 4,000
Goods available for sale 55,000
Cost of goods sold 22,000

How much is the Ending Inventory?

a. 23,000
b. 32,000
c. 33,000
d. 22,000

64
Problem 4- Solution

Goods available for sale 55,000

Cost of goods sold (22,000)
Ending Inventory 33,000

c. 33,000

65
 7
Inventory
Estimation
Gross Profit Method
Gross profit is assumed to be relatively constant from period to
period. Thus, the gross profit is used to compute for the gross profit
rate (GPR) which in turn is used to determine the cost ratio.

The cost ratio is used in estimating the cost of inventory and cost of
goods sold

67
Gross Profit Rate
Gross profit rate can be expressed as a percentage
● Based on Sales
○ GPR is computed by dividing gross profit by the net sales
● Based on Cost of Goods Sold
○ GPR is computed by dividing gross profit by the cost of goods sold

68
Illustration:
1. If GPR based on cost is 25%, what is the GPR based on sales?
Net Sales (Squeeze) 125%
COGS (constant) (100%)
Gross profit rate based on cost (given) 25%

Gross profit rate based on sales (25% / 125%) = 20%

2. If GPR based on sales is 20%, what is the GPR based on cost?

Net Sales (constant) 100%
COGS (Squeeze) (80%)
Gross profit rate based on sales (given) 20%

Gross profit rate based on cost (20% / 80%) = 25%

69
Cost Ratio
Cost ratio may be derived from the gross profit rate. The following may
provide guidance in deriving cost ratios from gross profit rates:
● Cost ratio from GPR based on sales = 100% Net Sales – GPR based on
Sales
● Cost ratio from GPR based on cost = 100% COGS / Net Sales

70
Illustration:
1. If GPR based on sales is 20%, what is the cost ratio?
Net Sales (constant) 100%
COGS (squeeze- cost ratio) (80%)
Gross profit rate based on sales (given) 20%

2. If GPR based on cost is 25%, what is cost ratio?

Net Sales (Squeeze) 125%
COGS (Constant) (100%)
Gross profit rate based on cost (given) 25%

Cost Ratio (100% / 125%) = 80%

Regardless of the basis of the GPR, cost ratio is the same

71
Net Sales
For the purpose of estimating inventory, only sales returns are deducted
from gross sales in computing for net sales.

Sales discounts and allowances are not deducted.

72
Illustration: Gross profit based on sales
On October 1, 20x1, a flood destroyed the warehouse of ABC Co. and all the inventories contained therein. Off-site
back up of data base shows the following information:

Inventory, Jan. 1 14,500

Accounts Payable, Jan. 1 6,000
Accounts Payable, Sept. 30 3,000
Payments to suppliers 50,000
Freight-in 5,000
Purchased returns and discounts 2,500
Sales from Jan. to Sept. 75,000
Sales returns 5,000
Sales discounts 2,000
GPR based on sales 20%
Additional info: Goods in transit on Oct. 1, 20x1 amounted to 2,000 while goods out on consignment were 1,200.
Damaged materials can be sold at a salvage value of 500. Compute for the inventory loss due to the flood.

73
Illustration:
Step 1: Compute for the net purchases using the Accounts Payable T-Account
Accounts Payable

6,000 Beg. Balance

Payments to Suppliers 50,000 47,000 Net purchases (squeeze)

Ending Balance 3,000

74
Illustration:
Step 2: Extend the net purchases computed in step 1 to the inventory T account and squeeze for
the ending inventory
Inventory

Beg. Balance 14,500

Net Purchases 47,000
Freight-in 5,000 56,000 COGS*

10,500 Sept. 30 (Squeeze)

COGS is computed as follows:

Gross Sales 75,000
Sales Returns (5,000)
Net Sales 70,000
Multiply by: Cost ratio 80%
COGS 56,000

75
Illustration:
The inventory loss due to flood is computed as follows:

Inventory, Sept. 30 10,500

Goods in transit (2,000)
Goods out on consignment (1,200)
Salvage Value (500)
Inventory loss due to flood 6,800

76
Illustration: COGS
You were engaged to assist in reconstructing ABC Co.’s records after an operating system
crashed on August 1. ABC Co. does not have an established business continuity plan or a disaster
recovery program and only the following information has been determined:

Increase in Inventory 16,000

Decrease in Accounts Payable 8,000
Payments to Suppliers 70,000

Accounts Payable Inventory

8,000 Beg. Balance Beg. Balance 0

Payment to Suppliers 62,000 Net Purchases
Net Purchases 62,000 46,000 COGS (squeeze)
70,000 (Squeeze)

End 0 16,000 End

77
Retail Method
The retail method is often used in the retail industry for measuring
large quantities of inventories with rapidly changing items for which
it is impracticable to use other costing methods.

This method is similar to the gross profit method.

78
Retail Method
The following are peculiar to the retail method:

a. The cost ratio is computed directly without regard to the gross

profit rate
b. Net mark-ups and net mark-downs are considered

Net mark-ups = markups less markup cancellation

Net mark-downs = markdowns less markdown cancellation

79
Retail Method
The retail method is applied using either the:
1. Average cost method
2. FIFO cost method
3. Conservative cost method

80
Average cost method
Under this method, the TGAS at cost (beg. Inventory + net purchases) is
determined and divided by the TGAS at sales price/retail to come up with
the cost ratio

Cost ratio (Ave.) = TGAS at cost

TGAS at retail

COGS = Net Sales x Cost Ratio

Ending Inventory at cost = Ending Inventory at retail x Cost Ratio

81
FIFO cost method
Similar to the Average cost method, the difference is that the beginning
inventories at cost and at retail are simply excluded from TGAS when
computing for the cost ratio.

Cost ratio (FIFO) = TGAS at cost less beg. Inventory at cost

TGAS at retail less beg. Inventory at retail

Ending Inventory at cost = Ending Inventory at retail x Cost Ratio

COGS = TGAS at cost – Ending Inventory at cost

82
Conservative cost method
Similar to the Average cost method, the difference is that any net
markdowns are excluded from TGAS at retail when computing for the cost
ratio.

Cost ratio (Conservative) = TGAS at cost

TGAS at retail + Net Markdown

Ending Inventory at cost = Ending Inventory at retail x Cost Ratio

COGS = TGAS at cost – Ending Inventory at cost

83
Illustration:
Presented below is information pertaining to ABC Co.
Cost Retail
Inventory, Jan. 1 8,700 14,000
Purchases 55,300 80,300
Freight-in 2,000 -
Purchase Discounts 500 -
Purchase Returns 5,200 8,600
Departmental transfer in 1,000 1,500
Departmental transfer out 800 1,200
Markups 6,000
Markup cancellations 2,000
Markdowns 12,000
Markdown cancellations 3,000
Abnormal Spoilage 5,000 7,000

84
Illustration:
Presented below is information pertaining to ABC Co.
Cost Retail
Sales 43,800
Sales Return 2,500
Sales Discounts 1,000
Employee Discounts 500
Normal Spoilage 200

Compute for the (a) COGS and (b) Ending Inventory using:
1. Average cost method
2. FIFO cost method
3. Conservative cost method

85
Illustration:
Presented below is information pertaining to ABC Co.
Cost Retail
Inventory, Jan. 1 8,700 14,000
Net Purchases 55,300 80,300
Freight-in 2,000 -
Purchase Discounts (500) -
Purchase Returns (5,200) (8,600)
Departmental transfer in 1,000 1,500
Departmental transfer out (800) (1,200)
Net Markups (6k – 2k) 4,000
Net Markdowns (12k – 3k) (9,000)
Abnormal Spoilage (5,000) (7,000)
TGAS 55,500 74,000

86
Illustration:
Presented below is information pertaining to ABC Co.
Cost Retail
TGAS 55,500 74,000
Net Sales* (42,000)
Ending Inventory at retail 32,000

Sales 43,800
Sales Return (2,500)
Employee Discounts 500
Normal Spoilage 200
Net Sales* 42,000

87
Illustration:
Average cost method:
Cost ratio = 55,500
74,000
= 75%

Ending Inventory at retail 32,000

Multiply by: Cost Ratio 75%
Ending Inventory at cost 24,000

TGAS at cost 55,500

Less: EI at cost (24,000)
COGS 31,500
88
Illustration:
FIFO cost method:
Cost ratio = (55,500 – 8,700)
(74,000 – 14,000)
= 78%

Ending Inventory at retail 32,000

Multiply by: Cost Ratio 78%
Ending Inventory at cost 24,960

TGAS at cost 55,500

Less: EI at cost (24,960)
COGS 30,540
89
Illustration:
Conservative cost method:
Cost ratio = 55,500
(74,000 + 9,000)
= 66.87%

Ending Inventory at retail 32,000

Multiply by: Cost Ratio 66.87%
Ending Inventory at cost 21,398

TGAS at cost 55,500

Less: EI at cost (21,398)
COGS 34,102
90
PRACTICE
PROBLEMS
Problem 1

Based on its general ledger, ABC Company reported inventory of P365,400 at the end of 2023. The
following items were included in the inventory total:

a. P31,500 worth of goods shipped by “Free Along Side” on December 31, 2023, and received by
ABC Co. on January 5, 2024.
b. Goods worth P12,400 ordered from a supplier on December 26, 2023, were shipped on
December 28 “Cost, Insurance and Freight” but had not arrived by Dec. 31, 2023.
c. P14,800 worth of goods ordered on December 25, 2023, were shipped to ABC Co. FOB ex-ship
on January 2,2024 and received on January 3, 2024.
d. A client ordered P21,600 worth of goods on December 27, 2023, which was dispatched FOB
seller on December 29, 2023, and received by the customer on January 5, 2024.
e. On December 29, 2023, goods worth P12,500 were shipped FOB Buyer to a client. The goods are
still on their way and the customer anticipates receiving them on January 5, 2024.

Required: What is the correct amount of inventory on December 31, 2023?

92
Problem 1

Unadjusted Balance 356,400

a. - (No Effect, correctly included)
b. - (No Effect, correctly included)
c. (14,800)
d. (21,600)
e. - (No Effect, correctly included)
Adjusted Bal. 320,000

93
Problem 2

ABC Inc .is a retailer of Italian furniture and has five major product lines: sofas, dining tables,
beds, closets, and lounge chairs. On December 31, 2023, quantity on hand, cost per unit, and
net realizable value (NRV) per unit of the product lines are as follows:

Product line Quantity of hand Cost per unit NRV per unit
Sofas 100 50,000 51,000
Dining Tables 200 25,000 22,500
Beds 300 75,000 80,000
Closets 400 37,500 38,000
Lounge Chairs 500 12,500 10,000

Required: Compute the valuation of the inventory of ABC Inc. on December 31, 2023, under
PAS 2 using the LCNRV. Record the appropriate journal entries, as necessary.

94
Problem 2

LCNRV Write-down
Sofas 5,000,000 -
Dining Tables 4,500,000 500,000
Beds 22,500,000 -
Closets 15,000,000 -
Lounge Chairs 5,000,000 1,250,000
1,750,000

Journal Entry:
Cost of Goods Sold 1,750,000
Dining table 500,000
Lounge Chairs 1,250,000

95
Problem 3

In 2023, ABC Co. experienced a decline in the value of inventory from

cost of P3,600,000 to net realizable value of P3,000,000.

In 2024, market conditions improved, the inventory had a cost of

P5,000,000 and net realizable value of P4,600,000.

Required: Compute for the amount of writedown and reversal, if any.

96
Problem 3

2023:
Cost 3,600,000
NRV (3,000,000)
Write-down 600,000

2024:
NRV 2024 4,600,000
NRV 20243 (3,000,000)
Reversal 1,600,000
*Limit (Prev. WD) 600,000

Reversal of Write-off 600,000

97
Problem 4

The following information was available from the inventory records of ABC Company for
January:
Units Unit Cost Total Cost
Bal. on Jan. 1 3,000 9.77 29,310
Purchases:
Jan. 6 2,000 10.30 20,600
Jan. 26 2,700 10.71 28,917
Sales:
Jan. 7 (2,500)
Jan. 31 (4,000)
Bal. on Jan. 31 1,200

98
Problem 4

(A) and (B) FIFO

Sales:
1/7 2,500 x 9.77 = 24,425
1/31 500 x 9.77 = 4,885
2,000 x 10.30 = 20,600
1,500 x 10.71 = 16,065
6,500 65,975 COGS
(78,827) TGAS
12,852 End. Inv

99
Problem 4

(A) and (B) FIFO

TGAS in units 7,700

Units sold (6,500)
Units in End. Inv 1,200
x 10.71
Ending Inventory 12,852

TGAS 78,827
COGS (Squeeze) (65,975)
Ending Inventory 12,852

100
Problem 4

C. Weighted Average

WAC = TGAS in Peso

TGAS in Units

WAC = 78,827 = 10.24

7,700

Units Sold 6,5000

WAC x 10.24
COGS 66,560
TGAS (78,827)
Ending Inventory 12,267

101
Problem 4

D. Moving Average
Units Unit Cost Total Cost
Jan. 1 3,000 9.77 29,310
Jan. 6 2,000 10.30 20,600
5,000 9.98 49,910
Jan. 7 (2,500) 9.98 (24,950)
2,500 24,960
Jan. 26 2,700 10.71 28,917
5,200 10.36 53,877
Jan. 31 (4,000) 10.36 (41,440)
Balance Jan. 31 1,200 12,437

COGS = 24,950 + 41,440 = 66,390

102
Problem 5
Cost Retail
Beginning inventory P650,000 P1,200,000
Purchases 9,000,000 14,700,000
Freight in 200,000
Purchase returns 300,000 500,000
Purchase allowances 150,000
Departmental transfer in 200,000 300,000
Net markups 300,000
Net markdowns 1,000,000
Sales 9,500,000
Sales discounts 100,000
Employee discounts 500,000
Estimated normal shoplifting losses 1,000,000

103
Problem 5
Cost Retail
Beginning inventory P650,000 P1,200,000
Purchases 9,000,000 14,700,000
Freight in 200,000
Purchase returns (300,000) (500,000)
Purchase allowances (150,000)
Departmental transfer in 200,000 300,000
Net markups 300,000
Net markdowns (1,000,000)
TGAS 9,600,000 15,000,000

104
Problem 5

Cost Retail
TGAS 9,600,000 15,000,000
Net Sales* (11,000,000)
Ending Inventory at retail 4,000,000

Sales 9,500,000
Employee Discounts 500,000
Normal Loss 1,00,000
Net Sales* 11,000,000

105
Illustration:
Average cost method:
Cost ratio = 9,600,000
15,000,000
= 64%

Ending Inventory at retail 4,000,000

Multiply by: Cost Ratio 64%
Ending Inventory at cost 2,560,000

TGAS at cost 9,600,000

Less: EI at cost (2,560,000)
COGS 7,040,000
106
Illustration:
Conservative cost method:
Cost ratio = 9,600,000
(15,000,000 + 1,000,000)
= 60%

Ending Inventory at retail 4,000,000

Multiply by: Cost Ratio 60%
Ending Inventory at cost 2,400,000

TGAS at cost 9,600,000

Less: EI at cost (2,400,000)
COGS 7,200,000
107
Illustration:
FIFO cost method:
Cost ratio = (9,600,000 – 650,000)
(15,000,000 – 1,200,000)
= 64.86%

Ending Inventory at retail 4,000,000

Multiply by: Cost Ratio 64.86%
Ending Inventory at cost 2,594,204

TGAS at cost 9,600,000

Less: EI at cost (2,594,204)
COGS 7,005,796
108
Thank you!

109